The rules of RESPs are far from simple. There are rules for contributions, rules for the grant money, rules for withdrawals, rules if you go to school, rules if you don't. there are rules for everything. Before we go too far in explaining the rules, we need to establish an understanding of some of the important terms with regards to the RESP.
RESP – Registered Education Savings Plan. This is a type of account designed for money that will be used when a child goes to school. It is one of the best ways to save for a child's future education. An RESP is an education savings plan registered under the Income Tax Act.
SUBSCRIBER – A subscriber is the person who creates the plan and who makes contributions to the plan. This could be anyone. However, if the RESP is a family plan, the beneficiaries must be related by blood or adoption to the subscriber. For this purpose, blood relationships include children, brothers, sisters, grandchildren and great-grandchildren. The subscriber is responsible for tracking the total amount contributed to all RESPs on behalf of the beneficiary.
BENEFICIARY – A beneficiary is the person who will draw upon the RESP to finance their education.
INDIVIDUAL PLAN – An individual plan is an RESP set up by a subscriber for one beneficiary. A subscriber may designate anyone as the beneficiary of the plan, including themselves, a spouse or common-law partner.
FAMILY PLAN – A family plan is an RESP set up by a subscriber on behalf of one or more beneficiaries. However, each beneficiary must be under 21 years of age at the time of designation and must be related to the subscriber by blood or adoption. Children, grandchildren, brothers and sisters are considered blood relations, while nieces and nephews are not.
CESG – The Canada Education Savings Grant (CESG) was introduced in 1998 to provide an incentive for individuals to save for the post-secondary education of children through Registered Education Savings Plans (RESPs). Simply, the government puts in 20 cents for every dollar contributed to a RESP. There are a lot of rules around the CESG but suffice it to say, it is the primary benefit of RESPs and makes the RESP the primary choice for savings for education. In 1997, the government enhanced the rules for RESPs. The 2007 federal budget proposed to increase the maximum annual RESP contribution qualifying for the 20% CESG to $2,500 from $2,000, which increases the maximum CESG per beneficiary for 2007 and subsequent years to $500 from $400.
Enhanced CESG – In 2004, the government introduced the Enhanced CESG, which is available for families with family income below $81,941. This allows lower-income families to earn an additional 10 cents or 20 cents, depending on their income, per contributed dollar up to the first $500 contributed annually. If your family income is between $40,970 and $81,941 the CESG is enhanced to 30% on the first $500 contributed. If your family income is below $40,970, the CESG is enhanced to 40%.
Educational Assistance Plans (EAP) – An educational assistance payment (EAP) means any amount, other than a refund of contributions, paid out of an education savings plan to or for an individual to assist in furthering their education at a post-secondary level. This includes either the CESG or the growth within the plan. Certain conditions must be met for payments to qualify as EAPs.
Post Secondary Education Payment (PSE) – A post-secondary education (PSE) withdrawal, is a withdrawal of contributions made by the subscriber during the time a beneficiary is eligible to receive EAPs. Since the beneficiary is pursuing post-secondary education, the subscriber may withdraw his/her contributions without being required to repay any grant amounts. The subscriber must sign the request for PSE Capital Withdrawals
Accumulated Income Payment (AIP) – The AIP is the money withdrawn from the RESP if the beneficiary does not go to school. AIPs apply only to the growth in the plan. It does not apply to the contributions made by the subscriber or the CESG money. AIPs are taxable income and are subject to the taxpayer's regular income tax rate plus an additional federal penalty tax of 20%. To avoid the tax penalty and retain the full tax benefits of the savings, the AIP (up to $50,000) can be rolled into a Registered Retirement Savings Plan (RRSP) or a spousal RRSP if there is contribution room
For the next few posts, I will explore some of the following aspects of RESPs:
Different Types of RESPs
Making Sense of the CESG
Understanding the RESP carry forward rules
Investment Strategies for RESPs
What happens if the beneficiary does not go to school
What happens if the subscriber dies
Getting money out of the RESPs
The ins and outs of RESPs (MapleMoney)